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So far we’ve been paying AMT rates (26%) on most of our ordinary income, yet still 0% on some of our cap gains income and generally 15% and then 18.8% on the rest.

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audrey...........might want to do a marginal tax analysis. I believe if you are in AMT territory phaseout region, every additional $, will reduce your exemption by 0.25, thus increasing your income by 1.25. Your marginal tax rate will then increase by that same factor 26% x 1.25 = 32.5%. If you are in NIIT land, add another 3.8% = 36.3%. Easy to verify your own situation w/ a tax calculator.

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audrey...........might want to do a marginal tax analysis. I believe if you are in AMT territory phase region, every additional $, will reduce your exemption by 0.25, thus increasing your income by 1.25. Your marginal tax rate will then increase by that same factor 26% x 1.25 = 32.5%. If you are in NIIT land, add another 3.8% = 36.3%. Easy to verify your own situation w/ a tax calculator.

I’m not sure. The NIIT applies only to cap gains income when total income exceeds $250K. The AMT rates only to ordinary income although in my case I tend to have a very low AMT exemption which means most of my ordinary income is taxed at 26%. Fortunately my ordinary income has been quite low.

I guess the marginal rate thing is about changes in new taxes owed due to increased income.

I have reason to believe we can avoid the AMT once we reach RMD stage. This has been my main focus. We’ll see this year.

Yes I can model it further, but up until now our marginal rates have been such that doing Roth conversions made no sense.

@Independent, my policy is to use the longest term historical average that I can find from a reputable source. For chained CPI I found a recent Forbes article that gave a value from 2000 to 2017 of just about 2%. For SS COLAs I think I found a page on ssa.gov that gave a 20+ year average of 3%.

I'll guess that the small difference in time frame is generating misleading differences in the numbers you want.

I went to the source that both Forbes and SSA use - the Bureau of Labor Statistics.
I picked matching dates - December 1999 vs. December 2016.

SS benefits currently* vary by CPI-W. I think that brackets will vary by C-CPI-U. I put the standard CPI-U between them for comparison.

This is about the longest time frame available because the BLS started calculating the C-CPI-U in Dec 1999

The table rows are the raw index values, the simple ratio, and the annualized growth rates.

I’m not sure. The NIIT applies only to cap gains income when total income exceeds $250K. The AMT rates only to ordinary income although in my case I tend to have a very low AMT exemption which means most of my ordinary income is taxed at 26%. Fortunately my ordinary income has been quite low.

I guess the marginal rate thing is about changes in new taxes owed due to increased income.

I have reason to believe we can avoid the AMT once we reach RMD stage. This has been my main focus. We’ll see this year.

Yes I can model it further, but up until now our marginal rates have been such that doing Roth conversions made no sense.

And now we’re entering the stage where IRMAA comes into play.

Did you mean you have a very low reduction of AMT exemption?
Your comment about NIIT made me think you had just entered AMT territory and AMT exemption was still high. Same w/ your 26% tax rate on ordinary income implies little phaseout of exemption.

I'm hoping the new law means AMT avoidance is easier now since exemption is higher and exemption phase out income is much higher.

Ever feel you're boxed in on all sides? I used to convert up to top of 15% bracket following the general advice here. I thought of converting into the 25% bracket when it seemed that the 15% level wasn't going to make a significant dent in the balances in the short remaining time........but stopped when I realized it wasn't going to be 25%, but 30% instead due to the pushing of 15% conversions pushing 0% QDIV/LTCG into the 15% bracket. Now with RMDs, in lush stock market yrs like this one w/ those cursed active funds giving you those large taxable distributions, you can get AMT rates of 32.5-36.3%.......so I avoided those 30% rates on purpose , only to run into the 32-36% rates instead.

Did you mean you have a very low reduction of AMT exemption?
Your comment about NIIT made me think you had just entered AMT territory and AMT exemption was still high. Same w/ your 26% tax rate on ordinary income implies little phaseout of exemption.

I'm hoping the new law means AMT avoidance is easier now since exemption is higher and exemption phase out income is much higher.

Ever feel you're boxed in on all sides? I used to convert up to top of 15% bracket following the general advice here. I thought of converting into the 25% bracket when it seemed that the 15% level wasn't going to make a significant dent in the balances in the short remaining time........but stopped when I realized it wasn't going to be 25%, but 30% instead due to the pushing of 15% conversions pushing 0% QDIV/LTCG into the 15% bracket. Now with RMDs, in lush stock market yrs like this one w/ those cursed active funds giving you those large taxable distributions, you can get AMT rates of 32.5-36.3%.......so I avoided those 30% rates on purpose , only to run into the 32-36% rates instead.

No, I meant my AMT exemption becomes small, but so is my ordinary income and it is the only thing the 26% is applied to after the qualified dividends and long-term cap gains income is removed. That’s the impact of the long term cap gains rate income - to reduce my AMT exemption. Nothing else drives the AMT in my case.

So my strategy has been to severely reduce realized gains in the future by taking care of some old positions over the past couple of years before DH qualifies for Medicare in 2020. I’m hoping to skip AMT in 2018 - we’ll see.

Obviously I need to do a few more calcs. But generally yes, boxed in by high income although most of it is taxed at cap gains rates until SS and RMD income appear.

I’ll definitely be paying higher taxes then, but if I convert to Roth now I’ll be paying the same higher taxes now. So I don’t see a benefit. Our IRAs are no more than 15% of our investable assets, and our SS income even at 70 will be lowish as we both retired very early. So it will increase our income but maybe not as much as most people. I’ve joked that our SS income will just pay for the taxes on the SS income and the Medicare premiums, with almost nothing left over.

One possible opportunity, after major stock market losses, cap gains distributions all but disappear for a couple of years plus there are tax loss harvesting opportunities. That would be a good time to convert.

I'll guess that the small difference in time frame is generating misleading differences in the numbers you want.

...

Thanks for the data, I really appreciate it.

I went back and looked, and I was using 3% for SS COLAs based on data from the SSA website. But looking at it again, it has COLAs from the 70's, which were obviously much higher on average.

I plugged in the 2.6% number and it does affect things somewhat, but from my spreadsheet it looks like the annual amount of Roth conversions overwhelms the SSA COLA effect.

__________________
"At times the world can seem an unfriendly and sinister place, but believe us when we say there is much more good in it than bad. All you have to do is look hard enough, and what might seem to be a series of unfortunate events, may in fact be the first steps of a journey." Violet Baudelaire.

I compare my 2039 AGI to the 2039 tax brackets and find that I fill some of the lower ones and part of one of the middle ones, which becomes my marginal rate. Like most who do this exercise, this marginal bracket in 2039 is a few brackets higher than what I pay today, so I should consider Roth converting more between now and then.

So my main question is, did I get the math fundamentally correct? That is, did I make any errors in the above logic which could materially affect the resulting conclusion?

Your logic is correct, many successful investors have a tax bomb waiting in their 401K's & IRA's. It beats the alternative of having no money in your 401k.
Strategies I'm (1967) exploring to minimize the impact:
Roth conversions
start to take and or spend 401K /IRA money @59.5
Take SS at 62
Tax free muni's for non IRA money

On the plus side. My Accountant always said having to pay taxes is a good problem to have, because it means you made money.

audreyh1 has it exactly correct. In my case, it appears that, since I have 21 years, I can do conversions anywhere between about $9K and $50K, and that can move me two or more brackets in my 70's. The savings is, well, take a look at the width of the middle tax brackets and multiply that by the differences between two of the middle brackets. It's serious coin that can go to my kids rather than the IRS.

Another thing is, for me anyway, I'd like my income to be low for the next few years while my kids are in college, so I am limiting my conversions for some of those 21 years. I was curious to know if I was getting myself into a high-tax situation from which I couldn't extricate myself.

But I see marko's point as well. I start looking at RMD's at 70, IRMAA, SS, kids' college, lifetime consumption smoothing, the probability of me even being alive to spend the money, the 4% rule, the market, asset allocations, the probability of Congress changing the tax laws again, and so sometimes I feel like I just want to take some very simple actions (like convert to the top of the X% bracket) and then go do something else because chances are I can't perfectly optimize everything all the time.

@Luck_Club, my grandfather, a tax accountant, had the same saying.

__________________
"At times the world can seem an unfriendly and sinister place, but believe us when we say there is much more good in it than bad. All you have to do is look hard enough, and what might seem to be a series of unfortunate events, may in fact be the first steps of a journey." Violet Baudelaire.

Your logic is correct, many successful investors have a tax bomb waiting in their 401K's & IRA's. It beats the alternative of having no money in your 401k.
Strategies I'm (1967) exploring to minimize the impact:
Roth conversions
start to take and or spend 401K /IRA money @59.5
Take SS at 62
Tax free muni's for non IRA money

On the plus side. My Accountant always said having to pay taxes is a good problem to have, because it means you made money.

It all looks good, except for the social security part. By adding SS to Roth conversions (taxable) and 401k/IRA withdrawals (taxable) you are adding another taxable income stream.

If withdrawals and conversions are large enough you'll pay tax on the Social Security stream. Sure SS tax is capped at 85%, but it is still a tax burden to consider. Instead, consider delaying SS until age 70, and take larger withdrawals, or make a larger Roth conversion to deplete the 401K/IRA accounts sooner. It will significantly reduce the amount of RMDs, lowering the taxes due, but you'll have taxes to pay on SS - eventually.

Finally, when considering the entire income stream up to age 63*, be mindful of the income limit on Medicare Part B premiums (generally not discussed but it's a bomb too!). Currently, a single individual pays the quoted Medicare premium up to $85K of modified AGI. Above that number IIRMA kicks in and there is a surcharge to the quoted Part B premium, and it's not little.

* Age 63 because Medicare looks at Modified AGI two years before the current premium year to determine if IIRMA applies. To avoid it you need to reduce incomes to the maximum allowed before IIRMA. MAGI also includes tax-exempt interest.

My plan is to convert as much as I can from tax-deferred to Roth starting at 57 until 70. My yearly spending is only about 70k and the top of the 12% bracket is 101.4k (77.4k + 24k standard deduction) That leaves me around 20k after taxes to convert for 13 years. At 70, the RMD will equal the conversion so I will just stop converting.

The calculator link provided above by LawrenceWendall is a great one for checking to see if you’ll have the “Social Security Tax Torpedo” issue. The link is has unfortunately been shortened so can’t be copy and pasted. It can be found by searching for “Social Security Tax Calculator: Are Your Retirement Benefits Taxable?”.

We’ve got the Tax Torpedo problem (too high of a percentage of our retirement money in tax deferred IRAs). Our solution is nearly the same as Lawrence’s. Here’s our plan:

We FIREd our FT employers at age 59 ½. Between 59 ½ and age 70 ½ we’re busy with Roth conversions. A home-grown Excel spreadsheet helps us determine the annual Roth conversion amount. We’re being careful to spread our tax load across those 11 or so years keeping our Effective Tax rate as low as possible. We’re currently showing 12.7% average across that range of years.

All of our Roth conversions should be finished by ages 70 or 71. We should be paying near-zero income taxes from then on! That’s what our tax software (TurboTax) is showing. Yes, I know that tax laws change annually and that our TurboTax software’s tax laws are “frozen” in time, however, doing future taxes using our very best dollar figures is as accurate as it probably gets. I feel good about the results and re-do our future taxes annually.

Healthcare insurance needs, our solution. Neither DW nor I had employers that helped with healthcare costs during retirement. Wife and I are currently age 62, so don't yet qualify for Medicare. We’re getting our Healthcare by working seasonally 4 months of the year for the local IRS center. When in “non-work status”, or furloughed (laid off) we continue to enjoy government-provided healthcare, dental and vision. Yes, we pay our “small” part of the insurance costs. We would recommend this to others not-yet-65 and needing insurance.

Also while furloughed we can collect unemployment, until we get recalled for work in January. This is a nice “bonus” on top of the insurance.

This solution has been working well for us!

Call us "Happily semi-retired" for now then "Happily Retired" at age 65 with Medicare and supplemental insurance.

The current standard deduction for a single person age 65 and older is $13,600. Yes, it will increase based on Chained CPI.

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Good point. I'm 49 now so didn't think about the increased standard deduction. Not sure it makes that much of a difference with the numbers I have, but it would be more accurate if I make the change. Thanks.

__________________
"At times the world can seem an unfriendly and sinister place, but believe us when we say there is much more good in it than bad. All you have to do is look hard enough, and what might seem to be a series of unfortunate events, may in fact be the first steps of a journey." Violet Baudelaire.

Good point. I'm 49 now so didn't think about the increased standard deduction. Not sure it makes that much of a difference with the numbers I have, but it would be more accurate if I make the change. Thanks.

That is really LONG range planning !

The tax laws will have changed several times by then. I recently read that another tax cut is now in the works.

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